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Monday, February 16, 2015

Taxation, Redistribution, and Social Insurance

Thomas Piketty provided many interesting revelations
about economics and society in his book Capital in the Twenty-First Century. Some of the most fascinating were the
insights provided concerning the development of a distinct middle class in the
years after World War II. In particular,
it was revealing to note that middle class wealth developed more readily in the
high-tax welfare states that developed in Europe in the postwar years, than in
the lower-taxed, less-regulated economy and society of the US. This phenomenon and Piketty’s data were discussed
in The Creation of the Middle Class.

Piketty uses a simple prescription to define economic
class: the top 10% in terms of wealth comprise the upper class, the next 40%
the middle class, and the bottom 50% make up the lower class. Prior to the tumultuous era spanning the two
world wars and the Great Depression the upper class in Europe owned about 89%
of the wealth, while the US was slightly more egalitarian with an upper class
in possession of 81%. The fraction of
wealth residing in the upper class bottomed out in both regions around 1970 at
60% in Europe and about 64% in the US.
The data implies that the wealth possessed by the middle class in Europe
increased from 5% to 35% over that period, while it increased from about 14% to
25% in the US.

An obvious question to ask of this data is why the middle
class fared so much better in Europe than in the US. One is tempted to assume that the higher tax
rates existing in Europe simply take money from the rich and distribute it to
those in the middle and lower classes.
The situation is much more complicated than that—and much more
interesting as well. According to
Piketty:

“….modern redistribution does
not consist in transferring income from the rich to the poor, at least not in
so explicit a way. It consists rather in
financing public services and replacement incomes that are more or less equal
for everyone, especially in the areas of health, education, and pensions.”

All countries have their unique tax policies. Consider the situation in France where
Piketty provides this description of the tax base:

“….a detailed study of French
taxes in 2010, which looked at all forms of taxation, found that the overall
rate of taxation (47 percent of national income on average) broke down as
follows. The bottom 50 percent of the
income distribution pay a rate of 40-45 percent; the next 40 percent pay 45-50
percent; but the top 5 percent and even more the top 1 percent pay lower rates,
with the top 0.1 percent paying only 35 percent.”

The taxes are
certainly high by US standards, but it would be difficult to describe them as a
“soak the rich” scheme. It would
actually be more accurate to describe the system as one that taxes most heavily
those who benefit the most from the services provided by the taxation. There is an intriguing sense of fairness
about this approach.

Tony Judt discussed the European welfare states in his
book Postwar. He provided this insight:

“….although the greatest
immediate advantage was felt by the poor, the real long-term beneficiaries were
the professional and commercial middle class.
In many cases they had not previously been eligible for work-related
health, unemployment or retirement benefits and had been obliged, before the
war, to purchase such services and benefits from the private sector. Now they had full access to them, either free
or at low cost. Taken with the state
provision of free or subsidized secondary and higher education for their
children, this left the salaried professional and white collar classes with
both a better quality of life and more disposal income. Far from dividing the social classes against
each other, the European welfare state bound them closer together than ever
before, with a common interest in its preservation and defense.”

So, the French middle class pays the highest tax rates,
but benefits most from the services provided by the state and comes out ahead,
thriving under the system.

An outfit called Citizens for Tax Justice tallied the total tax rates (federal, state, and local) paid
by income group for the US.

By this reckoning, the US middle class pays about 30% of
their income in taxes. This compares
with 45-50% in France. However, the
French middle class has grown wealthier than that of the US by paying a 15-20% higher
tax rate. How can this be?

What if an insurance company came to some US middle class
household and made the following offer: “Pay us 15% (or 20%) of your salary and
we will provide you and your family with a guaranteed income level, childcare,
healthcare, education, and a pension at retirement that will allow you to
maintain your lifestyle.” Would that be
considered a good deal? Remember that
financial advisors are telling those in the US that they should be saving at
least 10% of their income just for retirement expenses.

One could argue that the proposal does not add up; the
services promised would cost more than the revenue provided by the insurance
premium. The insurance representative
would answer with the obvious reply that that is the way insurance is supposed
to work. If everyone pays their 15%,
different classes of people will receive different levels of benefits. Some will pay more and receive less, some
will pay less and receive more, but all will pay the same rate and have the
same access to benefits. The lower class
may have most need of income support, but they will have the same access to
healthcare and education as everyone else.
The wealthy will have need for the services provided, but by paying
about the same share they will have access to the services and support those who are less able to contribute. The people who will demand most in terms of
services from the system—relative to their ability to pay—are the middle
class. They will benefit the most.

This helps explain how Piketty’s indirect redistribution
works via provision of services, and also provides an explanation for why the
European middle class has fared better.
Casting taxation as a mechanism for providing social insurance that
guarantees the services one might need as one goes through life seems more
productive than thinking of it as a wasteful confiscation. Of course, the government would have to
actually provide the services.

We in the US are, at present, paying taxes at a healthy
rate, but receiving services at an unhealthy rate. Demanding lower taxes will not improve the
service. We should be demanding better
services—the government works for us, doesn’t it?—and we should be willing to
pay for them.

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About Me

Hi, my name is Rich Couch. I spent my first career as a physical scientist. Now that I am retired I have chosen to go in another direction. I have had a lifelong love of books and an urge to write. Since I am not a story teller and I am way too old to start a new career I have found an outlet in writing essays combining reviews and my opinions of books and articles on politics and current affairs. My hope is that others will find what I have produced interesting and informative--and well written.